Week 3 - Elasticity and Market Efficiency EC1101E, NUS, Spring 2020. - - PowerPoint PPT Presentation

Week 3 - Elasticity and Market Efficiency

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Plan for today

• Elasticity
• Welfare analysis: market efficiency

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Announcement(s)

• Midterm Exam: Thursday, March 12. 6.30-8.30p.m, at

LT34 (Faculty of Science, near the bus stop), e-Exam

• Friday February 14: ExamSoft demo with IT staff

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Announcement(s)

• Midterm Exam: Thursday, March 12. 6.30-8.30p.m, at

LT34 (Faculty of Science, near the bus stop), e-Exam

• Friday February 14: ExamSoft demo with IT staff

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

How about your supply for tutoring?

• If tutoring PSLE students were $5 per hour, how many hours would you like to tutor each week?
• If tutoring PSLE students were $25 per hour, how many hours would you like to tutor each week?
• If tutoring PSLE students were $50 per hour, how many hours would you like to tutor each week?
• If tutoring PSLE students were $100 per hour, how many hours would you like to tutor each week?
• If tutoring PSLE students were $250 per hour, how many hours would you like to tutor each week?

Price

(per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

(AVERAGE)

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Supply curve for tutoring – EC1101E, NUS, Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Supply curve for tutoring – EC1101E, NUS, Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Supply curve for tutoring – EC1101E, NUS, Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Remarks on the observed Supply Curve for hours tutoring

• Resembles very well any textbook Supply Curve
• Clearly follows the Law of Supply:
• The higher the price, the more hours you are willing to

supply

• Why is that the case?
• The higher the rate, the more profitable it is
• Inverse reasoning: opportunity cost.
• The more hours parents want you to tutor, the fewer

free hours you will have à The value of your free time increases à For each additional hour, you demand more money

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Remarks on the observed Supply Curve for hours tutoring

• Resembles very well any textbook Supply Curve
• Clearly follows the Law of Demand:
• The higher the price, the more hours you are willing to

supply

• Why is that the case?
• The higher the rate, the more profitable it is
• Inverse reasoning: opportunity cost.
• The more hours parents want you to tutor, the fewer

free hours you will have à The value of your free time increases à For each additional hour, you demand more money

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Remarks on the observed Supply Curve for hours tutoring

• Resembles very well any textbook Supply Curve
• Clearly follows the Law of Demand:
• The higher the price, the more hours you are willing to

supply

• Why is that the case?
• The higher the rate, the more profitable it is
• Inverse reasoning: opportunity cost.
• The more hours parents want you to tutor, the fewer

free hours you will have à The value of your free time increases à For each additional hour, you demand more money

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

How to stop animal hunting?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

US President Theodore Roosevelt, 1909-10

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

King of Spain, 2012

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Today: Why do some people claim that promoting the hunting industry is the *best* way to protect wildlife? We will learn about elasticity of demand and supply when trying to answer this question.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Today: Why do some people claim that promoting the hunting industry is the *best* way to protect wildlife? We will learn about elasticity of demand and supply when trying to answer this question.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Protecting endangered species? offer hunter tours to kill them legally!

• Goal: protect endangered species
• One possible solution? Offer Crazy Rich Tourists the chance to

kill them for a fee, legally.

• Disclaimer: Not claiming this is the solution we would

advocate, for obvious reasons.

• However, this is a reason that has been argued by many in the

past and even in the present. Next, we will see why.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

The market for hunting

• Demand: Pay $ to kill one animal
• Supply: Stock of animals (agencies get fee for the

tour)

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Suppose first hunting is illegal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Suppose first hunting is illegal

• Demand: Relatively small because it is costly

for Crazy Rich Tourists to meet the illegal agencies etc. (also: risky)

• Supply: Illegal tour agencies know the spots

where to kill animals (also: risky)

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Suppose first hunting is illegal

• Demand: Relatively small because it is costly

for Crazy Rich Tourists to meet the illegal agencies etc. (also: risky)

• Supply: Fixed stock. Illegal tour agencies

know the spots where to kill animals (also: risky)

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Suppose first hunting is illegal

Q

(# animals)

Price

(per animal)

D

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q

(# animals)

Price

(per animal)

S

Suppose first hunting is illegal

D

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

Suppose first hunting is illegal

D S

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

Suppose first hunting is illegal

D S

All animals killed in a brief period of time

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

Suppose first hunting is illegal

D S

All animals killed in a brief period of time Agencies make loads of money… for one year.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

D0 S

Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

D0 S

Now suppose that hunting becomes legal Demand shifts: it’s easier for more Killer Tourists to meet the agencies

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

D0 S

Now suppose that hunting becomes legal

D1

$2,000

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

D0 S

Demand shifts: it’s easier for more Killer Tourists to meet the agencies. Agencies make *even more* loads of money… for one year. Now suppose that hunting becomes legal

D1

$2,000

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

100 Price

(per animal)

Q

(# animals)

$1,000

D0 S

Now suppose that hunting becomes legal

D1

$2,000

All animals killed in a brief period of time… … just that for a higher price

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Owner of Hunting Agency

Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Those Crazy Rich Tourists will want to come year after year!

Owner of Hunting Agency

Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Then I should make sure next year we still have animals around! More realistic setting: animals can and do reproduce

Owner of Hunting Agency

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Especially, since farming wild animals is legal now! So I won’t go to jail for that More realistic setting: animals can and do reproduce

Owner of Hunting Agency

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Hunting agencies do have incentives to preserve the stock of animals Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Hunting agencies do have incentives to preserve the stock of animals This is critical Now suppose that hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

More realistic setting: animals can and do reproduce In fact, as any other business, they will respond to prices

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Hunting agencies supply curve

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Hunting agencies supply curve

S

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Market after hunting becomes legal

D0 D1

$1,000

Old equilibrium before hunting is legalized

100

S0 S1

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Market after hunting becomes legal

S1 D0 D1

$1,000 $1,600

New equilibrium after hunting is legalized

100 130

S0

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Market after hunting becomes legal

S1 D0 D1

$1,000 $1,600

New

100 130

S0

Old

Note: if hunting agencies allowed to “farm” animals, then the stock of endangered species increases from 100 to 130. Given agencies want to make profits in the long term, this is a sustainable equilibrium that guarantees animals in the long run

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Market after hunting becomes legal

S1 D0 D1

$1,000 $1,600

New

100 130

S0

Old

Note: if hunting agencies allowed to “farm” animals, then the stock of endangered species increases from 100 to 130. Given agencies want to make profits in the long term, this is a sustainable equilibrium that guarantees animals in the long run.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What if there is a demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• Paradoxically, the more people want to go hunting…
• …the more animals will be present
• (details of a demand shock: next slide)

What if there is a demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Market after hunting becomes legal

S1 D0 D1

$1,000 $1,600

New

100 130

S0

NewER

D2

Suppose: Demand shock Higher quantity of animals in equilibrium 160 $2,200

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• Suppose farming can respond faster to price changes
• …then even more animals will be present

Market after hunting becomes legal

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

Farming becomes more efficient/dynamic

S1 D0 D1

$1,000 $1,600 100 130

S0

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 D0 D1

$1,000 $1,600 100 130

S0 𝑻 "1

Farming becomes more efficient/dynamic

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 D0 D1

$1,000 $1,600 100 130

S0 𝑻 "1

Farming becomes more efficient/dynamic

$1,200 160

New

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 D0 D1

$1,000 $1,600 100 130

S0 𝑻 "1

Farming becomes more efficient/dynamic

$1,200 160

New

More efficient/dynamic farming Higher quantity of animals in equilibrium

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Protecting endangered species

1.

Legalize hunting

2.

Allow agencies to farm endangered species

3.

Profit maximization will do the rest

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Protecting endangered species

1.

Legalize hunting

2.

Allow agencies to farm endangered species

3.

Profit maximization will do the rest

• RE-RE-RE policy: Ethically reprobable, reprehensible,

revolting.

• But it does work! Some advocate it as the best

solution

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What can we learn, more generally?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What can we learn, more generally?

• Why does a more dynamic/efficient farming lead to

higher number of animals?

• Because agencies can respond faster to changes in

prices

• This refers to the elasticity

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 𝑻 "1

Farming becomes more efficient/dynamic

More ELASTIC supply More INELASTIC supply

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 𝑻 "1

Initially

$1,200 $1,600

130 110

• A price increase of $400
• Quantity increases by 20

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 𝑻 "1

As farming becomes more efficient/dynamic

$1,200 $1,600

210 150

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

(per animal)

Q

(# animals)

S1 𝑻 "1

Farming becomes more efficient/dynamic

$1,200 $1,600

210 150

• A price increase of $400
• Quantity increases by 60

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply

• The more elastic the supply, the better for the

protection of endangered species

• We want a precise measure: 𝑓$ = %∆()

%∆*

• How responsive is quantity supplied to a price

increase

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply

• The more elastic the supply, the better for the

protection of endangered species

• We want a precise measure: 𝑓$ = %∆()

%∆*

• How responsive is quantity supplied to a price

increase

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

6782668 668

= 18.18%

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

6782668 668

= 18.18%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

6<8826=88 6=88

= 33.33%

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

6782668 668

= 18.18%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

6<8826=88 6=88

= 33.33%

• 𝑓$ =

%∆() %∆*

=

6@.6@ 77.77 = 0.5454

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

6782668 668

= 18.18%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

6<8826=88 6=88

= 33.33%

• 𝑓$ =

%∆() %∆*

=

6@.6@ 77.77 = 0.5454

• Every 1% increase in price results in a 0.54% increase in

quantity supplied

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

6782668 668

= 18.18%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

6<8826=88 6=88

= 33.33%

• 𝑓$ =

%∆() %∆*

=

6@.6@ 77.77 = 0.5454

• Every 1% increase in price results in a 0.54% increase in

quantity supplied

• %∆𝑅$ = 100×

(/01

)

2(345

)

(345

)

= 100×

=6826C8 6C8

= 40%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

6<8826=88 6=88

= 33.33%

• 𝑓$ =

%∆() %∆*

=

D8 77.77 = 1.20

• Every 1% increase in price results in a 1.20% increase in

quantity supplied

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply

• es

0: Perfectly inelastic supply

• Large changes in prices barely change quantity supplied
• Vertical Supply curve
• es

∞: Perfectly elastic supply

• Small changes in prices induce huge changes in quantity supplied
• Horizontal Supply curve

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply

• es

0: Perfectly inelastic supply

• Large changes in prices barely change quantity supplied
• Vertical Supply curve
• es

∞: Perfectly elastic supply

• Small changes in prices induce huge changes in quantity supplied
• Horizontal Supply curve

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• 𝑓F = %∆(5

%∆*

• How responsive is quantity demanded to a price

increase

• Inelastic demand: not price sensitive
• Elastic demand: very price sensitive

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• 𝑓F = %∆(5

%∆*

• How responsive is quantity demanded to a price

increase

• Which good has a very inelastic demand?
• Which good has a very elastic demand?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• 𝑓F = %∆(5

%∆*

• How responsive is quantity demanded to a price

increase

• Which good has a very inelastic demand?
• Which good has a very elastic demand?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• 𝑓F = %∆(5

%∆*

• How responsive is quantity demanded to a price

increase

• Which good has a very inelastic demand? Insulin
• Which good has a very elastic demand? Mee Goreng

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• Which good has a very inelastic demand? Insulin
• People with diabetes *really* need it
• They will pay whichever price for the daily

quantity prescribed

• Which good has a very elastic demand? Mee Goreng

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand

• Which good has a very inelastic demand? Insulin
• People with diabetes *really* need it
• They will pay whichever price for the daily

quantity prescribed

• Which good has a very elastic demand? Mee Goreng
• Has many close substitutes: Mee Rebus, Hokkien Mee,

etc.

• If price increases “too much”, consumers switch to
• ther mee types

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price Q

(# animals)

Elasticity of Demand - graphically

$200 $100

D

920 900

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Elasticity of Demand - graphically

$200 $100

D

920 900

• Price doubles
• Quantity demanded

barely changes

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Elasticity of Demand - graphically

$200 $100

D

920 900

• We want to be more

precise

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price Q

(# animals)

Elasticity of Demand - graphically

$200 $100

D

920 900

• %∆𝑅F = 100×

(/01

5

2(345

5

(345

5

= 100×

G882G=8 G=8

= −2.17%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

=882688 688

= 100%

• 𝑓F =

%∆(5 %∆*

=

2=.6J 688

= 0.0217

• Every 1% increase in price results in a 0.02% decrease in

quantity demanded

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Elasticity of Demand - graphically

$200 $100

D

920 900

• %∆𝑅F = 100×

(/01

5

2(345

5

(345

5

= 100×

G882G=8 G=8

= −2.17%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

=882688 688

= 100%

• 𝑓F =

%∆(5 %∆*

=

2=.6J 688

= 0.0217

• Every 1% increase in price results in a 0.02% decrease in

quantity demanded

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Elasticity of Demand - graphically

$200 $100

D

920 900

• %∆𝑅F = 100×

(/01

5

2(345

5

(345

5

= 100×

G882G=8 G=8

= −2.17%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

=882688 688

= 100%

• 𝑓F =

%∆(5 %∆*

=

2=.6J 688

= 0.0217

• Every 1% increase in price results in a 0.02% decrease in

quantity demanded

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Elasticity of Demand - graphically

$200 $100

D

920 900

• %∆𝑅F = 100×

(/01

5

2(345

5

(345

5

= 100×

G882G=8 G=8

= −2.17%

• %∆𝑄 = 100×

*/012*345 *345

= 100×

=882688 688

= 100%

• 𝑓F =

%∆(5 %∆*

=

2=.6J 688

= 0.0217

• Every 1% increase in price results in a 0.02% decrease in

quantity demanded

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

S

When demand is very inelastic…

D

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

S

When demand is very inelastic…

• Q* virtually determined

by demand only

• P* virtually determined

by supply only

D

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price Q

D S0 S1

When demand is very inelastic…

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

D S0 S1

• Supply shift affects price p*
• Barely affects quantity

demanded in eq.

Q

When demand is very inelastic…

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - summary

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of demand - summary

• 𝑓F = ∞

Perfectly elastic demand

• 𝑓F > 1

Elastic demand

• 𝑓F = 1

Unit-Elastic demand

• 𝑓F < 1

Inelastic demand

• 𝑓F = 0

Perfectly inelastic demand

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of supply - summary

• 𝑓$ = ∞

Perfectly elastic supply

• 𝑓$ > 1

Elastic supply

• 𝑓$ = 1

Unit-Elastic supply

• 𝑓$ < 1

Inelastic supply

• 𝑓$ = 0

Perfectly inelastic supply

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - comments

• Direction matters!
• Why is it useful?
• If there are taxes or shifts, we know who is

affected.

• It also allows us to anticipate consequences of

policies

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 2 = −50% %∆𝑄 = 100× 8 − 7 7 = 14.3% 𝑓F = %∆𝑅F %∆𝑄 = −50 14.3 = 3.49

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 2 − 1 1 = 100% %∆𝑄 = 100× 7 − 8 8 = −12.5% 𝑓F= %∆𝑅F %∆𝑄 = 100 12.5 = 8

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 2 = −50% %∆𝑄 = 100× 8 − 7 7 = 14.3% 𝑓F= %∆𝑅F %∆𝑄 = −50 14.3 = 3.49 %∆𝑅F = 100× 2 − 1 1 = 100% %∆𝑄 = 100× 7 − 8 8 = −12.5% 𝑓F= %∆𝑅F %∆𝑄 = 100 12.5 = 8

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – comments (1)

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 2 = −50% %∆𝑄 = 100× 8 − 7 7 = 14.3% 𝑓F= %∆𝑅F %∆𝑄 = −50 14.3 = 3.49 %∆𝑅F = 100× 2 − 1 1 = 100% %∆𝑄 = 100× 7 − 8 8 = −12.5% 𝑓F= %∆𝑅F %∆𝑄 = 100 12.5 = 8

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – midpoint formula

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 1 − 2 1.5 = −66.6% %∆𝑄 = 100× 8 − 7 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 8 − 7 7.5 = 13.33% 𝑓F= %∆𝑅F %∆𝑄 = −66.66 13.33 = 5

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – midpoint formula

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 2 − 1 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 1.5 = 66.6% %∆𝑄 = 100× 7 − 8 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 7.5 = −13.33% 𝑓F= %∆𝑅F %∆𝑄 = 66.66 −13.33 = 5

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – midpoint formula

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 1 − 2 1.5 = −66.6% %∆𝑄 = 100× 8 − 7 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 8 − 7 7.5 = 13.33% 𝑓F= %∆𝑅F %∆𝑄 = −66.66 13.33 = 5 %∆𝑅F = 100× 2 − 1 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 1.5 = 66.6% %∆𝑄 = 100× 7 − 8 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 7.5 = −13.33% 𝑓F= %∆𝑅F %∆𝑄 = 66.66 −13.33 = 5

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p

Elasticity – midpoint formula

8 7 7 8 1 2 1 2

%∆𝑅F = 100× 1 − 2 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 1 − 2 1.5 = −66.6% %∆𝑄 = 100× 8 − 7 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× 8 − 7 7.5 = 13.33% 𝑓F= %∆𝑅F %∆𝑄 = −66.66 13.33 = 5 %∆𝑅F = 100× 2 − 1 𝑅𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 1.5 = 66.6% %∆𝑄 = 100× 7 − 8 𝑄𝑏𝑤𝑓𝑠𝑏𝑕𝑓 = 100× −1 7.5 = −13.33% 𝑓F= %∆𝑅F %∆𝑄 = 66.66 −13.33 = 5

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - comments

• Direction matters!
• Why is it useful?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - comments

• Direction matters!
• Why is it useful?
• If there are taxes or shifts, we know who is

affected.

• It also allows us to anticipate consequences of

policies

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - example

• Suppose the roads are very congested
• You want people to use public transport instead of private

vehicles

• You double up supply of public transport
• Will this solve your problem?
• You can anticipate it if you know how demand looks like!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - example

Q p p Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p p Q

S1 S1 S0 S0

Elasticity – Public transport market

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity – Public transport market

Q p p Q

S1 S1 S0 S0 D D

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p p Q

S1 S1 S0 S0

• Very elastic demand for public transport
• Doubling supply
• Quantity nearly doubles
• Price diminishes marginally

Elasticity – Public transport market

• Very inelastic demand for public transport
• Doubling supply
• Quantity barely changes
• Price diminishes dramatically

D D

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Q p p Q

S1 S1 S0 S0

Correct scenario if your goal is to vacate the roads from cars

Elasticity – Public transport market

D D

Welfare Economics

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Are markets really useful in allocating goods? Can we measure market benefits?

Both prefer more muffins to fewer muffins

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Both prefer more muffins to fewer muffins Is this a Pareto efficient allocation?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Now suppose we know exactly how much they value each muffin

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Hi Prof! This muffins look so good ah!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Shut up Weasley!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

I bet they’re damn

• shiok. I pay you $5

for one. Come on prof!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation? I bet they’re so

• yum. I pay you $5

for one. Come on prof! Hmmmm …. Those Weasleys stink, but maybe I could do that….

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Thanks prof!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation? Actually,… I’ll pay you $4 for another

• ne. Can?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

You’re so greedy Weasley!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

But… ok!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

But… ok!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

So shiok prof!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Can I get one more? I pay you $3

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

What? Get off now, will ya? Pay me $4 or no deal, Weasley!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Ok Prof, no

• worries. No deal.

Thank you!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Note: $ allows us to achieve Pareto improvements

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

Note: $ allows us to achieve Pareto improvements. All transactions make them both better off.

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$5 $5 $4 $4 $3 $3 $2 $2

Is this allocation a (market) efficient allocation?

When no further transactions are made à market efficiency

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Let’s see a (slightly) more general example next

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

If we let them trade freely, what is going to happen?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

Market allocates goods efficiently: Those who value them most get them

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

• If we did the experiment in class, we would see that,

eventually, those willing to pay most for the muffins would get them.

• In the real markets, of course, people don’t go around

asking who is willing to pay how much for each muffin: this happens through the “invisible hand”

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

• Perfectly competitive market

Efficient allocation

• A good is allocated efficiently when units are consumed

by those who value them the most.

• Recall: efficiency ≠ fairness

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

$4 $6 $5 $8 $3 $5 $4 $6 $2 $4 $3 $4 $1 $1 $2 $2

• Perfectly competitive market

Efficient allocation

• Equilibrium quantity maximizes total benefits (for

sellers and for consumers)

• We are going to see this next

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Albert is willing to pay $250 per

• hour. He gets it, and pays only

$125! His “surplus” is $125

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Amanda is willing to tutor at $6 per hour. She gets it, and gets paid $125! Her “surplus” is $119 !!

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Baiyun is willing to pay $245 per

• hour. She gets it, and pays only

$125! Her “surplus” is $120

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Barack is willing to tutor at $20 per hour. He gets it, and gets paid $125! His “surplus” is $105 !!

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Etc.

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

How about Xing? Will she find someone at $120 an hour?

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125 Those who value tutoring most are the

• nes that will get tutors in the market.

Note: “value most” includes “and can pay”

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

How about Naz? Will he find someone to pay him $130 an hour?

Price

($ per hour)

Hours tutoring per week 25 50 100 250 200 10 20 30 40 5 150

Market for tutoring – Spring 2020

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125 Those who sell at lower prices will manage to sell their product/services Intuition: those for whom the opportunity cost is too high will not enter the market because the price does not compensate them

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Generally (next slides)

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Consumer surplus: Difference between what consumers are willing to pay and what they actually pay

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Consumer surplus (alt.): Difference between the value for consumers and what they actually pay

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

Producer surplus: Difference between what sellers are willing to accept and what they actually get paid

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

TOTAL SURPLUS (or Total Benefits) Difference between what sellers are willing to accept and what they actually get paid

Price

25 50 100 250 200 10 20 30 40 5 150

EC1101E, NUS, Spring 2020 Guillem Riambau

15 125

TOTAL SURPLUS (or Total Benefits) CS + PS

Price

What if demand is very inelastic? What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Two afterthoughts

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Inelastic Demand

$100

D

1,000

S

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price Q

Inelastic Demand

$100

D

1,000

S

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

Inelastic Demand

$100

D

1,000

S CS is nearly infinite: does this make sense?

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

What if there is a positive demand shock?

S

Q

D

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

What if there is a positive demand shock?

D S

Q

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

What if there is a positive demand shock?

S

Q

D0 D1

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Price

What if there is a positive demand shock?

S

Q

D1

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What happens to Consumer Surplus? What happens to Producer Surplus?

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

How can CS increase if they price has increased?

CS before CS after

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

How can CS increase if they price has increased? 1) They are willing to pay more now 2) They are buying a lot more units

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS before PS after

Next Week

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Government Intervention in Markets (Price Controls, Taxes, Subsidies) Sometimes government wants to intervene E.g. Controlling rents E.g. Taxing goods to reduce consumption How does that affect consumers and producers? Who suffers more? Who benefits?

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS before PS after

Why does PS increase?

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS before PS after

Why does PS increase?

Prices willing to accept have not changed But they sell more units, and at a higher price

What if there is a positive demand shock?

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Total surplus increases Everyone in that market is “happier”

Takeaways

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Takeaways

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Elasticity What it means How to measure it Why it is useful Welfare analysis Perfectly competitive markets à efficient allocations Those who value goods the most get them Next week: why Surplus is relevant

Kahoot!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

%Increase in Qdemanded= 133.33%; %Increase in price=66.66%; Elasticity=2

Kahoot!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Bread as it is more broadly defined

Kahoot!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

Real estate: you cannot produce condos/HDB blocks so fast as you can produce masks or increase the supply of cab rides

Kahoot!

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

PS after

CS=0; PS>0. Just draw it to convince yourselves.